Capital Controls and the

Trans-Pacific Partnership
Presentation to the Stakeholder Forum, Chicago, Sept. 10, 2011,
by Sarah Anderson, Institute for Policy Studies

Dramatic Shifts in Capital Controls Thinking and Practice

The negotiations over the Trans-Pacific Partnership between the U.S. government and eight other countries
are occurring at a time of dramatic transitions in the economics field and in the policy arena on the issue of
capital controls. These policies include various measures designed to prevent speculative bubbles or rapid
capital flight.
After decades of blanket opposition, the International Monetary Fund now endorses capital controls on
inflows of speculative capital under certain circumstances.1 The IMF even recommended outflows controls
in a number of countries facing capital flight in the wake of the 2008 crisis, such as Iceland and Ukraine.2
They also found that nations which had controls in place before the current crisis were among the least hard
hit, echoing Asian Development Bank and United Nations research.3 IMF, World Bank, and Cornell
University studies that analyzed longer time periods found no correlation between capital account
liberalization and economic growth in developing countries.4
Over the past year and a half, the IMF has been broadly supportive of the increasing number of emerging
market countries that are using controls on inflows to deal with surges of hot money. On August 3, 2011,
for example, the IMF executive board described Brazils use of capital controls as an appropriate tool to
manage foreign investment inflows.5
One reason the Brazilian government has wide flexibility to use capital controls is that it has not signed a
trade or investment agreement with the United States. For several decades, it has been standard U.S. policy
to include sweeping restrictions on this policy tool in U.S. free trade agreements (FTAs) and bilateral
investment treaties (BITs). Governments must permit transfers relating to a covered investment to be made
freely and without delay into and out of its territory. Foreign investors are allowed to sue governments in
supra-national tribunals over alleged violations of these rules.
In effect, the current policy promotes capital account liberalization between trade partners, regardless of the
implications for financial stability.6

Obama Administration Seeks to Maintain Status Quo

Earlier this year, more than 250 economists sent a letter to the administration urging trade and investment reforms
to allow greater flexibility on capital controls.7 Given the severity of the global financial crisis and its aftermath,
nations will need all the possible tools at their disposal to prevent and mitigate financial crises, they wrote.
Signatories included several economists who have been generally supportive of free trade but are critical of the
capital control restrictions (e.g., Arvind Subramanian of the Peterson Institute for International Economics and
Nancy Birdsall, President of the Center for Global Development), as well as former IMF officials (e.g., Olivier
Jeanne of Johns Hopkins University) and a Nobel laureate (Joseph Stiglitz).
Treasury Secretary Timothy Geithner responded to the economists with a letter in which he stated that the
administration will seek to preserve current policy.8 He argued that reforms are unnecessary because
governments have sufficient alternatives to capital controls to deal with volatility. Likewise, USTR
spokeswoman Carol Guthrie told a Bloomberg reporter that the U.S. expects to push for open capitaltransfer rules in the Trans-Pacific Partnership negotiations. Existing rules provide the necessary flexibility
for governments, including through the standard policy tools such as monetary and fiscal policies, exchange
rate flexibility, and macro-prudential measures, Guthrie said.9 An Inside US Trade article on the TransPacific Partnership, based on anonymous administration sources, reported that on capital controls, the U.S.
investment proposal essentially retains the language included in past trade deals.10
Capital Controls Exceptions in Existing U.S. Agreements
The Obama administration position appears rigid in comparison not only to the IMF, but also to previous
U.S. regimes. The majority of the 52 existing U.S. trade agreements and bilateral investment treaties restrict
governments from putting controls on capital flows, with no exceptions to prevent or mitigate financial
volatility. However, in eight cases, U.S. negotiators have allowed some form of safeguard for balance of
payments crises.
These exceptions date back to the administration of President Ronald Reagan. For example, the US-Turkey
BIT, signed in 1985, includes this exception:
In the exceptional financial or economic circumstances relating to foreign
exchange, the Republic of Turkey may temporarily delay transfers of the type
specified in Article IV (1)(e) but only (i) in a manner consistent with Article II;* (ii)
for the time period necessary to restore its reserves of foreign exchange to a
minimally acceptable level, but not to exceed three years from the date when the
transfer is requested; and (iii) provided that the national or company has an
opportunity to invest the proceeds in a manner which will preserve their value until
transfer occurs.

Article II covers national treatment and most-favored nation treatment obligations.

Variations on this exception for balance of payments crises can be found in the following existing U.S.
agreements:

Agreement
US-Israel FTA
US-Turkey BIT
US-Bangladesh
BIT
US-Egypt BIT
US-Tunisia BIT
US-Sri Lanka BIT
NAFTA
US-Jamaica BIT

Date
signed
Apr-85
Dec-85

Date of
entry into
force
Aug-85
May-90

Relevant provision
no transfers provisions whatsoever
Protocol 2(b)

Mar-86
Mar-86
May-90
Sep-91
Dec-92
Feb-94

Jul-89
Jun-92
Feb-93
May-93
Jan-94
Mar-97

Protocol 4
Protocol 10
Protocol 3
Protocol 6
Article 2104: Balance of Payments
Protocol 3

A recent IMF report on one of the countries that received a Reagan administration exception Bangladesh
credits capital controls with preventing the global flight to safety that left so many poor economies in
shambles after the crisis erupted in 2008. Bangladesh instead doubled its central bank reserves during that
period.11
Special Dispute Settlement Procedures in U.S. Bilateral Trade Agreements with
Singapore, Chile, and Peru
Three countries involved in the Trans-Pacific Partnership negotiations have bilateral trade agreements with
the United States that include annexes laying out special dispute settlement procedures related to capital
controls.
These annexes represent compromises struck in the trade agreements between the United States and
Singapore and Chile, which went into force in 2004. In the aftermath of the global financial crisis of the late
1990s, both of those nations sought a general balance of payments exception in their bilateral trade deals
with the United States. Throughout most of the 1990s, the Chilean government subjected capital inflows to
the encaje (strongbox in Spanish)a one year, non-interest paying deposit with the central bank. The
deposit requirement varied from 10% to 30%, and the penalty for early withdrawal ranged from 1% to 3%.
Chile faired better than most other Latin American countries during the Mexican peso crisis in 1994 and the
Asian crisis a few years later. While the role of capital controls has been intensely debated, an IMF research
review concluded that the encaje, combined with other financial sector reforms, allowed the government
more monetary policy autonomy and shifted the composition of foreign investment towards the longer
term.12
The Bush administration, however, could not be persuaded to allow a general balance of payments
safeguard. Instead, they conceded only to special dispute settlement procedures. Similar procedures were
included in the 2006 U.S.-Peru Free Trade Agreement. Here are the key elements of these special
procedures:
1. They extend the normal cooling off period before foreign investors can file claims from six months to
a year after the government action in question, with some exceptions.

2. The Chile and Peru annexes (but not Singapore) limit damages arising from certain restrictive measures
on capital inflows to the reduction in value of the transfers. Investors may not demand compensation
for the loss of profits or business. These limits do not apply to controls on outflows.
3. In the Chile and Singapore annexes (but not Peru), there is a provision eliminating the governments
liability for damages resulting from certain types of restrictions but only if they are in effect for no
more than a year and if they do not substantially impede transfers.
An interpretive note between the U.S. and Singapore governments expands on this point by suggesting
that arbitral judges not presume that outflows controls substantially impede transfers if they meet certain
criteria. One of these is that they must be price-based. This means that the type of quantitative
controls used by Malaysia at the height of the Asian financial crisis would not be covered by this
provision. Unremunerated reserve requirements such as those used by Chile in the 1990s would also be
unlikely to be covered, as the minimum stay requirement can act like a quantitative restriction on
outflows.13
These annexes cannot be considered actual safeguards to allow capital controls to prevent or mitigate
financial crisis. For one thing, no capital management policy that extends beyond a year would be covered
under any circumstances. The assumption that such measures should never be allowed for longer periods is
outmoded, given that some controls put in place during the lead-up or the aftermath of the 2008 crisis have
already stretched beyond the one-year mark. At a time when global policymakers are still trying to figure
out how best to re-regulate the financial system, these loophole-filled special dispute settlement procedures
should not be the model for the TPP.
Balance of Payments Safeguards in Other International Agreements
According to the IMF, the U.S. governments position of restricting capital controls, even in times of crisis,
makes it an international outlier. The global norm is to provide temporary safeguards on capital inflows
and outflows to prevent or mitigate financial crises, or defer that matter to the host countrys legislation.14
For example, the 2003 trade agreement between TPP countries Singapore and Australia includes the
following safeguard:15
ARTICLE 12: Restrictions to Safeguard the Balance of Payments
1. In the event of serious balance of payments and external financial difficulties or threat thereof, a Party may
adopt or maintain restrictions on payments or transfers related to investments. It is recognized that particular
pressures on the balance of payments of a Party in the process of economic development may necessitate the
use of restrictions to ensure, inter alia, the maintenance of a level of financial reserves adequate for the
implementation of its programme of economic development.
2. The restrictions referred to in Article 12.1 shall:
(a) be consistent with the Articles of Agreement of the International Monetary Fund;
(b) avoid unnecessary damage to the commercial, economic and financial interests of the other Party;
(c) not exceed those necessary to deal with the circumstances described in Article 12.1;
(d) be temporary and be phased out progressively as the situation specified in Article 12.1 improves;
(e) be applied on a national treatment basis and such that the other Party is treated no less favourably than any
non-Party.
3. Any restrictions adopted or maintained under Article 12.1, or any changes therein, shall be promptly notified to
the other Party.
4. The Party adopting any restrictions under Article 12.1 shall commence consultations with the other Party in
order to review the restrictions adopted by it.

And here is a similar safeguard in the trade agreement between TPP countries Malaysia and New Zealand:16
ARTICLE 17.3: Measures to Safeguard the Balance of Payments
1. Where a Party is in serious balance of payments and external financial difficulties or under threat thereof, it
may:
(a) in the case of trade in goods, in accordance with GATT 1994 and the WTO Understanding on the Balance-ofPayments Provisions of the GATT 1994, adopt restrictive import measures;
(b) in the case of services, adopt or maintain restrictions on trade in services on which it has undertaken specific
commitments, including on payments or transfers for transactions related to such commitments;
(c) in the case of investments, adopt or maintain restrictions with regard to payments relating to the transfer of
proceeds from investment.
2. Restrictions adopted or maintained under paragraph 1(b) or (c) shall:
(a) be consistent with the Articles of Agreement of the International Monetary Fund;
(b) avoid unnecessary damage to the commercial, economic and financial interests of the other Party;
(c) not exceed those necessary to deal with the circumstances described in paragraph 1;
(d) be temporary and be phased out progressively as the situation specified in paragraph 1 improves; and
(e)be applied on a national treatment basis and such that the other Party is treated no less favourably than any
third party.
3. In determining the incidence of such restrictions, the Parties may give priority to economic sectors which are
more essential to their economic development. However, such restrictions shall not be adopted or maintained for
the purpose of protecting a particular sector.
4. Any restrictions adopted or maintained by a Party under paragraph 1, or any changes therein, shall be notified
promptly to the other Party from the date such measures are taken.
5. The Party adopting or maintaining any restrictions under paragraph 1 shall promptly commence consultations
with the other Party from the date of notification in order to review the measures adopted or maintained by it.

Note that while these safeguards require the capital controls to be temporary, neither establishes a
maximum time period. Here is a sampling of the many additional trade and investment treaties that either
have a broad balance-of-payments safeguard or a special annex that completely carves out a trading partners
rules on capital controls:
Canada-Chile FTA (Annex G-09.1)17
Japan-Peru BIT (Article 20)18
Japan-Malaysia FTA (Article 88)19

ASEAN Comprehensive Investment

Agreement (Art. 16)20
EU-Korea FTA (Article 8.4)21

Recommendations:
Trans-Pacific Partnership negotiators should carefully review the numerous exceptions to the free
transfers rules in U.S. and international agreements. However, given the shifts in the economics debate
over these policy tools and heightened uncertainty in the international financial system, even these
exceptions may be too restrictive.
If transfers provisions are to be included in the TPP at all, negotiators should consider allowing greater
flexibility to use this proven tool as part of their toolbox for preventing and mitigating financial crisis. At a
minimum, changes should be made to the existing U.S. model to:
1. Establish safeguard mechanisms for financial crises that are not subject to investor-state dispute
settlement. At most, the provisions should be subject to state-to-state dispute settlement and even then
such procedures should only be available after a consultation process.

2. Remove short-term debt obligations and portfolio investments from the list of investments covered by
definition in the agreement.
3. Allow a government to restrict a transfer through the equitable, non-discriminatory, and good faith
application of its laws related to macroeconomic, monetary, or exchange rate policy.
About the Author
Sarah Anderson directs the Global Economy Project at the Institute for Policy Studies in Washington, DC. In 2009, she
served on the Investment Subcommittee of the U.S. State Departments Advisory Committee on International Economic Policy,
tasked with reviewing the U.S. Model Bilateral Investment Treaty. Contact: sarah@ips-dc.org, tel: 202 787 5227.
NOTES
1

International Monetary Fund, Recent Experiences in Managing Capital InflowsCross-Cutting Themes and Possible Policy
Framework, Approved by Reza Moghadam, February 14, 2011. See: http://www.imf.org/external/np/pp/eng/2011/021411a.pdf
2
Jeffrey M. Chwieroth, Controlling Capital after the Crisis of 2007-2009: The IMF and New Norms of Financial Governance, London
School of Economics (undated). See: http://personal.lse.ac.uk/chwierot/Images/ControllingCapitalCrisis.pdf
3
Kevin Gallagher, Policy space to Prevent and Mitigate Financial Crises, UNCTAD-G-24 Discussion Paper #58, Geneva: UNCTAD,
2010. See: http://www.ase.tufts.edu/gdae/Pubs/rp/KGCapControlsG-24.pdf
4
M. Ayhan Kose, Eswar S. Prasad, and Ashley D. Taylor, Thresholds on the Process of International Financial Integration, National
Bureau of Economic Research Working Paper 14916, 2009. See: http://www.nber.org/papers/w14916.pdf
5
International Monetary Fund, IMF Executive Board Concludes 2011 Article IV Consultation with Brazil, Public Information Notice
(PIN) No. 11/108, August 3, 2011. See: http://www.imf.org/external/np/sec/pn/2011/pn11108.htm
6
Sarah Anderson, Policy Handcuffs in the Financial Crisis, Institute for Policy Studies, February 2009.See: http://www.ipsdc.org/files/329/Policy%20Handcuffs%20in%20the%20Financial%20Crisis.pdf; and Comments on the U.S. Model Bilateral Investment
Treaty before the U.S. State Department and USTR, July 17, 2009. Available at: http://www.ipsdc.org/files/1366/IPS%20comments%20on%20Model%20Bilateral%20Investment%20Treaty.pdf
7
Letter to Secretary Clinton, Secretary Geithner, and Ambassador Kirk, January 31, 2011. See:
http://www.ase.tufts.edu/gdae/policy_research/CapCtrlsLetter.pdf
8
Timothy Geithner, letter to initial signatories of January 31, 2011 letter on capital controls and trade agreements, April 12, 2011. See:
http://www.ase.tufts.edu/gdae/policy_research/Geithner_response_to_capital_controls_letter.pdf
9
Mark Drajem, Stiglitz, Economists Fight Capital Controls in U.S. Trade Pacts, Bloomberg, Feb. 14, 2011. (subscription required)
10
U.S. TPP Investment Proposal Retains Investor-State, Breaks New Ground, Inside U.S. Trade, March 11, 2011. (subscription required)
11
International Monetary Fund, Bangladesh: 2009 Article IV ConsultationStaff Report, February 2010. See:
http://www.imf.org/external/pubs/ft/scr/2010/cr1055.pdf
12
Akira Ariyoshi, Karl Habermeier, Bernard Laurens, Inci Otker-Robe, Jorge Ivn Canales-Kriljenko, and Andrei Kirilenko, Capital
Controls: Country Experiences with Their Use and Liberalization, International Monetary Fund, May 17, 2000. See:
http://www.imf.org/external/pubs/ft/op/op190/index.htm.
13
Kevin P. Gallagher, Regaining Control? Capital Controls and the Global Financial Crisis, PERI Working Paper No. 250, February
2011. See: http://www.ase.tufts.edu/gdae/policy_research/KGCapControlsPERIFeb11.html
14
Jonathan D. Ostry, Atish R. Ghosh, Karl Habermeier, Luc Laeven, Marcos Chamon, Mahvash S. Qureshi, and Annamaria Kokenyne,
Managing Capital Inflows: What Tools to Use? IMF Staff Discussion Note SDN/11/06, April 5, 2011. See:
http://www.imf.org/external/pubs/ft/sdn/2011/sdn1106.pdf
15
Investment chapter of Singapore-Australia Free Trade Agreement. See: http://www.dfat.gov.au/fta/safta/chapter_8.pdf
16
Malaysia-New Zealand Free Trade Agreement. See:
http://www.miti.gov.my/cms/storage/documents/b60/com.tms.cms.document.Document_bd38b9ae-c0a81573-53e353e3801432ef/1/1.%20MNZFTA%20agreement.doc
17
See: http://www.international.gc.ca/trade-agreements-accords-commerciaux/agr-acc/chile-chili/chap-g26.aspx?lang=en&view=d#I
18
See: http://www.unctad.org/sections/dite/iia/docs/bits/japan_peru.pdf
19
See: http://www.miti.gov.my/cms/content.jsp?id=com.tms.cms.section.Section_5451c5df-c0a8156f-2af82af8-a1ebb9df
20
See: http://www.asean.org/22244.htm
21
See: http://trade.ec.europa.eu/doclib/docs/2009/october/tradoc_145177.pdf